We all know that these are challenging times to be a community banker, but I want to try to start this discussion on a more upbeat note. Is there any reason for community bankers to be optimistic about the state of the industry?

Robert Bennett: The feeling for so long was a sense of dread-made worse by what's this election going to do to us. Now there's a little bit of anticipation that things could get better. We're starting to sell some real-estate-owned. We're also starting to see a little loan demand. I'm not saying things are fixing to get better by any means, I think there's a little anticipation that things can't get any worse.

Randy Ferrell: I would say that we see [optimism] among our customers. For the first time in several years they see a light at the end of the tunnel. I think they are sitting back poised to move forward, poised to expand, but they want to see what's going to happen with the political situation. Maybe there were some answers with the election; I think [the extension of Bush-era tax cuts] is still an issue. It's hard to build a business plan when there are so many unknowns and I think some of the answers are getting a little bit clearer.

Ann Marie Mehlum: Our clients view us as being in the same boat with them because we worked so hard to work with them. I don't think they view us as 'them vs. us.'

Blair Hillyer: My real concern is for the senior citizens. I had a family that came in the other day and their CD came due from two or three years ago at 4.75 percent and we said, 'we are happy to give you 0.40 percent.' [At that rate of return,] they aren't going to want to travel or spend money at restaurants. It's a concern because in our area seniors make up a large share of the population and that's getting bigger all the time.

You're here in Washington to meet your elected officials and your regulators. What is it that you want to communicate to them?

Marx: The regulatory environment is bad. There are huge inconsistencies from agency to agency, and even within the same agency. Exams have been rough and will continue to be, at least for the foreseeable future.

Hillyer: There aren't too many loans [examiners] like right now. Ones you've already put on your books, or ones you're thinking about making. There are people looking for money right now and there are opportunities, but one of the challenges is that if you take a loan that another lender has thrown out or is throwing out and it goes bad, where do you hide? It's easier to just say no. Everywhere I go I'm asked how come people aren't making any loans and yet we've got more money to lend than we have in my lifetime.

Bennett: Community banks are overwhelmed by the flurry of regulation-I never will forget the day I downloaded the 200-page summary of Dodd-Frank. We have limited resources. We're a $200 million-asset bank and we have a dedicated compliance officer, but a lot of our peers don't. We've been overwhelmed with new regulations that we have to keep up with and enforce, at a time when margins are compressed.

Ferrell: One of the main topics of concern is capital. Community banks just don't have the sources of capital that we used to. If you find it, it's going to be a lot more expensive than is appropriate to pay for it. There's the government's small -business loan program, the $30 billion that they put out there, and there's a lot of questions regarding that. You need your regulator's approval to be able to participate and among the banks that then would qualify, there's a real question as to whether they would want the U.S. government as a partner.

But why wouldn't you want to participate? Isn't this a cheap source of capital?

Ferrell: Yes and no. It can be inexpensive if you're able to generate the net loan growth over a period of time. If not, then it turns into what can be a very expensive form of capital. We can't manufacture loan growth. My bank is in a relatively stable area (Northern Virginia) and loan growth over the last couple of years has been flat. The problem is that businesses are waiting to see what's going to happen with the economy before they expand. You're not going to hire up, you're not going to start employing people until you know where you are headed and whether you can afford to do that.

Mehlum: This is the most challenging time ever to be a community banker, and I've been in banking over 30 years. I am worried about long-term capital because we didn't really solve too big to fail. It's going to be tough for community banks long term to be able to compete in the capital markets. As an investor, would you invest in a community bank or would you invest in a bank that's too big to fail? I think everyday investors who want to have financial stocks in their portfolios are going to see a big difference between investing in a bank that could be closed on a Friday and one that won't ever be closed.

Let's go back to the government's small-business loan program. Are any of you interested in accessing this capital when it becomes available?

Hillyer: No. Under any conditions. We didn't take any of the TARP money either, even though I was called three times to see if we wanted it. I guarantee, we would have lost a heck of a lot of customers had we taken it. I had people asking me for weeks if we took it, to the point where I finally sent out a letter saying that we didn't. Whenever the clause in there says, 'the federal government can change the terms and conditions at any time,' that to me isn't much of a deal.

Mehlum: But we haven't seen that with this program yet. In this program, you have to use the money to lend, you're paying an interest rate that's better than what the large banks pay to the Feds. I'm hoping this small-business program does get defined and gets out there because I know there are banks that are going to take advantage of it because they see the loan demand.

Hillyer: Well I have plenty of money to lend right now. I don't need the money.

Mehlum: It's capital, it's not liquidity. We have plenty of liquidity as well. If you don't need it you don't need it, but in our market we lost a bank and we do have opportunity, so I think there are banks that will benefit by accessing this capital. I like this program from what I've seen of it so far.

Bennett: I think small banks are very cautious about proceeding with it. But I can understand the positives, too. I haven't made a decision at this point.

I'd like to ask about scale. We used to hear all the time that community banks could use their smallness to their advantage in building relationships, but now you are all dealing with an overwhelming regulatory burden and the costs that come with that. Do you need to get bigger to survive?

Hillyer: We're a $175 million-asset bank and we have a person-and-a-half who has been allotted time between audit and compliance. We also have a consultant that we use for compliance. I'm really concerned that it's going to require at least one more person or we're going to have to outsource it. Some of the economies of scale we've been able to get because people in the bank wore several hats. What I'd really like to see is subtraction of some of the regulations, like right of rescission and these privacy laws. We're all mailing out these things and printing these flyers and nobody reads of them. It's a total waste of money and trees and human effort. If we were to get rid of some of those, then some of the new burden wouldn't be so bad. But my experience is that they never go away, they just keep piling up.

So do you think you need to get bigger to keep up with the cost of compliance?

Hillyer: I don't think I can get big enough to do what I have to do, so I'm faced with being able to increase revenue elsewhere or cut some other costs.

Bennett: A lot of bankers have had the realization that we're going to have to live with a 0.7 percent [return on assets] vs. a 1.2. There's a realization that you aren't going to have as much control over your overhead that you've had in the past.

Mehlum: We're a $125 million-asset bank and we have 25 employees. I suspect that we probably use two full-time employees on compliance, although that's all of us doing a lot of compliance. I worry that with the 200 or so new regulations that we're expecting from Dodd-Frank that we may be too small to be able to cover those costs adequately. We're looking at that in our projections-do we need to grow a bit to be able to absorb those costs?

Hillyer: One of my big concerns is that as communities lose their banks, de novos don't start, banks are merged, banks fail...there's a heck of a lot of rural America that isn't going to get served. Washington wants us to make loans to grow small businesses and create jobs, but there are going to be places in rural Ohio where there aren't any banks for job creation.

Mehlum: There are a lot of predictions that the number of banks will dwindle. When I started in banking in the late 1970s there were over 15,000 banks and now we're down to less than 8,000 and I'm hearing predictions from the FDIC and investment bankers that we're going to be down to 3,000 or 4,000 or 5,000 banks. I think that every banker, just like every business owner, in this climate is having to look at their model and make sure that what they have going forward is sustainable. That means looking at partnering with other banks, and other kinds of collaborations.

Is there a threshold, a certain size you need to be to achieve economies of scale?

Ferrell: We used to hear that you had to be $1 billion to be on the radar screen, whatever that means. I've never been a fan of growth for growth's sake. We're a $630 million bank. Community banks have advantages over the larger banks because the customers can talk to the decision makers. In order to grow you have to do things that are not community-bank like. You have to do more '1-800 Trust Department,' and that's not what we're about.

Mehlum: But if you are a small bank and you add $100,000 in costs to comply with new regulations, and you've been making a 1 percent ROA, how do you maintain that?

Ferrell: You evaluate the options and you deal with it. We outsource our compliance function, and we've done it for years. We outsource our credit review, we outsource audit functions, and we feel in each case that it makes sense for us to do that.

Some of you have talked about growing by seizing new opportunities, but I wonder where the opportunity is. Is it new lines of business? Is it in new fees?

Hillyer: A lot of our fees have been too low for too long. Part of that was that we were making good money, our customers were, for the most part, pleased with us, and we were sort of trucking along. We've seen a flight back to community banks. We've picked up a heck of a lot of deposits in the last year even though we're not paying anything -I'm embarrassed by the rate we're paying them, to be honest with you-but they don't really care. Some have ventured out and gone to larger banks for better rates maybe, only to find that the loan officer is long gone now and the guy has to explain his business plan all over again to someone who doesn't know anything about his business.

Bennett: You hear the term pent-up demand a lot. If people have a good feel for what's going to happen, there's going to be some consumer spending. At the same time, we can say that there's probably some pent-up capital projects.

Hillyer: The high-priced mortgage has been a bread-and-butter product of ours forever. Other banks won't even talk to someone who wants to do a project like that; we do them all the time. But now, with all the paperwork-the HUD statement, the escrow requirements-it's almost cost prohibitive. I have employees complain daily about this, and we're at the point we're we are about to exit the business.

Mehlum: It's the same thing with consumer lending. One of the big differences that I've always felt between community banks and large banks-and I've worked in both-is that in a community bank, so often a customer comes in, has a need and you work out a solution that makes sense for them that also works for the bank. And it's not 'we can do this loan, this loan or this loan,' we work together to figure something out that is safe and sound for the bank that solves that customer's need. Now we're not able to do that. We have to say, 'we can [only] do this or this for you,' because there's so much paperwork and so many requirements.

What size loans are we talking about?

Mehlum: I'm talking about anything from $5,000 to $25,000. It's just too difficult to be able to tailor anything because you may not disclose it exactly right, and it's frustrating because our bank has never had a complaint from a customer for any of these types of loans.

Hillyer: The default rate is low, and the appreciation is great. The person got what they wanted, the bank made a profit on it and the bank took satisfactory risk that it could handle. So now rural in Ohio, if somebody wants that 20 or 25,000 loan, it's not going to happen. We can't staff to do it, and the tripwires for making mistakes on the compliance side aren't worth it.

Marx: When the Dodd-Frank bill was being debated, I was asked to send a letter to my congressman. So I sent an email that said that every bank in your district is a community bank and that if Dodd-Frank passes it's going to hurt every one of those banks-and their customers. I went on to tell him that if he were to come into my bank tomorrow for a $1,000 unsecured loan we'd have to give him 29 pieces of paper to read or sign. It used to be that he would fill out a 5 by 7 piece of paper, sign the application, I'd give him check and that'd be it. What we have now is ridiculous. We've got to make people [in Washington] understand that it has to stop.

Hillyer: If we were cheating the customer, somehow taking advantage of them in any way, word would get out and we're out of that business. It's self-policing. It's very frustrating when we can't tailor the product any more. Somebody loses, and it's going to be the customer.

I'd like to quickly ask about overdraft since the new opt in rules are in place now. Last year at this time there was a lot of concern among community bankers about the change and the impact it would have on customers and bank fee income. So what are you seeing?

Ferrell: We weren't excited when the Fed released its guidance for the overdraft rules, but I will say that it was a fair way to do it. Now that we've gone through the process, we've found out that the consumers want this product. It's turned out to be a nonissue.

Marx: It's the same at our bank. I've looked at our [nonsufficient funds] income for the two months since [new rules took effect] and if anything it's higher. We probably had about 65 percent of our folks opt in.

We only have a little time left. Anything else you want to get off your chests before we wrap up?

Marx: I'd like to say something about image. Other people are not going to toot bankers' horns. We need to toot our own horns. In our hometown, we know the owner of the newspaper, the editor. All we've got to do is take a little initiative and say, 'hey let's write an article for the paper, or let's talk to the City Club or the economic development folks.' We need to get the message out, but nobody's going to do it for us. We've got to do it ourselves.

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